Yet Another Mortgage Acceleration Plan to Stay Away From
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Before I get started, I wanted to let you know that Allianz and MN life forbid their policies from being sold in the structure I’m going to discuss. Also, this is a tough topic to fully discuss in a short newsletter. If you have questions, feel free to email me or give me a call.
What’s the “newest” mortgage acceleration scheme you need to avoid? It’s one to sell cash value life insurance of course.
Less compensation—also, it’s ironic that this mortgage acceleration program devised to sell life insurance has less compensation for the advisor than one without. The compensation using the mortgage acceleration IUL plan is 37% less than not using the plan.
Paying off a mortgage—let me state emphatically that it is a terrible decision from mathematical point of view to pay off a mortgage early. Paying off low interest/deductible debt is DUMB! Keep in mind that I’ve written two books on mortgages.
How does this “new” mortgage acceleration plan it work?
1) Pay off the existing fixed rate mortgage with a 1st position interest only HELOC (Home Equity Line of Credit)
2) Take the savings in mortgage payments and fund an IUL (Indexed Universal Life).
3) When the mortgage is paid off, take the money that was allocated to paying down the mortgage and increase the premiums to the IUL.
Why should his plan be avoided?
1) Because the client has to refinance their historically low 30-year fixed interest rate mortgage into a monthly floating loan (with rates that have nowhere to go but higher).
2) it’s a terrible financial decision to pay off low interest/deductible debt.
3) The sales process to make this sale is disingenuous and a compliance nightmare.
Let’s look at an example which will prove the stupidity of this plan:
Let’s use Mr. Smith, age 45, who has a $600,000 home with a $500,000 mortgage (3.75% interest rate). Assume Mr. Smith has excess cash flow of $2,500 after paying all expenses each month including the mortgage payment.
1) Mr. Smith refinances from a 30-year fixed at 3.75% to a monthly floating interest only loan tied to Libor (today’s rates are artificially low so I’m going to use an average over the life of the loan that is the same as the current fixed rate loan (which I don’t think will be the case, but let’s give the benefit of the doubt to this new program).
This will drop the monthly mortgage payment from $2,315.58 to $1,562.50 (saving the client $753.08 a month).
1a) Take the savings in mortgage payments and fund an IUL ($9,037 as an annual premium).
2) Tell the client that their $2,500 excess cash flow will be automatically used to pay down the mortgage. If they do so, it will take 10 years to pay off the $500,000 mortgage. This saves Mr. Smith $69,976 in mortgage interest (although keep in mind that the interest was deductible).
3) After the mortgage is paid off, take the excess cash flow ($2,500) and what was being budgeted to pay the 30-year mortgage payment ($2,315.58) to make a new annual IUL premium ($57,780 that is paid from year 11 until age 59).
4) Borrow from the IUL in retirement each year from age 60-85.
How much could be borrowed out tax-free each year if we used a 7% ROR in the IUL? $45,020
How does it compare to NOT using this idiotic plan?
If the client didn’t using this plan he would have kept his 30 year mortgage and funded his $2,500 a month surplus into an IUL until borrowing from it at age 60.
Interest Deduction—to make this a fair comparison, I took into account the fact that when paying off your mortgage early you lose the interest deduction. I took the difference in deduction assuming Mr. Smith is in the 30% tax bracket and added that back into the policy as premium. I also added the closing costs that Mr. Smith would not incur if he chose not to refinance.
How much could Mr. Smith borrow tax-free each year from this policy starting at ages 60-85? 75,734
Keep in mind the client still has 14 years to pay on the 30-year mortgage at $27,787 a year. Therefore, the following are the net numbers illustrating how much better NOT paying off your mortgage is over life of this client.
From years 61-74 the net positive amount when NOT paying off the mortgage early is: $40,979
From ages 75-85 the net positive amount when NOT paying off the mortgage earl is: $337,854
Total net positive by NOT paying off the mortgage quickly is: $378,833
Liquidity—there several other reason I do not like paying off mortgage debt early. One of them is lack of liquidity. When paying off mortgage debt, you now have a sizable amount of wealth in an illiquid asset vs. in this example an IUL that can be borrowed against. The people who push this program will tell you that the client will always have access to their 1st position HELOC, but it’s not protective of the client to have them rely on a lender to leave the HELOC open for decades.
Summary—is this “new” mortgage acceleration plan one you want to bring to your clients? One that has less liquidity/safety and generates less tax-free dollars in retirement? It’s no wonder Allianz and MN life said that their policies cannot be sold by agents pitching this plan. You can make up your own mind, but if you are a client centered advisor, you will avoid this plan.